Sun, Sep 16, 2012 - Page 8 News List

Editorial: Risks of liquidity-driven euphoria

Just a week after the European Central Bank (ECB) said it would implement unlimited bond buying to ameliorate the eurozone’s debt crisis, the US Federal Reserve announced on Thursday that it would launch a new round of bond buying at a pace of US$40 billion a month to prop up the economy in its own region. Most equities and commodities markets around the world moved higher on Friday amid the liquidity-driven euphoria, despite worries over a pickup in inflation expectations in the long haul.

The Fed’s timing on introducing the third round of quantitative easing (QE) was earlier than expected, although speculation about more easing measures had surfaced in recent months. The political factors associated with the upcoming US presidential election might have played an important role in pushing the Fed to make this decision sooner rather than later.

The Fed’s latest plan to purchase US$40 billion in mortgage-backed securities each month in an open-ended effort tied to what happens with the US job market is more flexible than the previous two rounds of QE. This unusual move underlines the grave concern that the US’ central bank has for the state of the US economy, but it also raises questions about the effectiveness of the measure, uncertainties over how long it could last and worries about how high the excess global liquidity triggered by this move could rise.

On the one hand, QE3 could have positive impacts on global stock markets, including Taiwan’s, in the near term. In the previous two rounds of QE, the TAIEX showed an average increase of 17.34 percent in the following six months. One could therefore expect QE3 to have the same positive impact on the local stock market, albeit with a smaller benefit this time because of weakening macro-fundamentals, including the still-weak performance in most European economies and the slowdown in China.

On the other hand, if the Fed sustains QE3 for as long as the US economy remains weak, it could put downward pressure on the US dollar, cause higher appreciation expectations on other currencies and lure potential capital inflows into their markets. The downward pressure on the greenback could also push commodities prices higher — in the previous two waves of QE the Reuters/CRB commodity index increased by 27.9 percent and 19.2 percent respectively, and consequently stoked the risk of global inflation.

In other words, concerns over higher inflation risks might put pressure on Taiwan’s central bank to exercise more credit control to prevent asset bubbles from forming. The nation’s consumer price index already expanded at its fastest pace in four years last month due to sudden rises in vegetable and fruit prices. If industrial product prices also climb higher because of rising commodities costs, Taiwan’s inflation might accelerate above the government’s target, which in turn could delay further relaxation of monetary policies to boost the nation’s weak exports.

Moreover, with the Fed’s QE3 now in place, one should look to see if policymakers in emerging economies adopt intervention measures to pre-empt the potential negative impacts from a surge in capital inflows and currency exchange rates. This means that a global devaluation race could reappear as countries act to protect the competitiveness of their export-oriented industries. However, because the latest QE is open-ended in nature, such currency wars would likely pose a longer-than-expected threat to the full recovery of the global economy.

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